April 2018 - The bitcoin bubble

Kim Oosterlinck, Émile Bernheim Centre

Kim Oosterlinck, several newspapers have written that with its drop in value last April, bitcoin was "the biggest bubble in history". What do you think?

Throughout history, there have been a number of sudden drops in the value of various assets, i.e. ‘bubbles’ bursting. Perhaps the best known example is the tulip bulb bubble in the 17th century, but there have also been bubbles in railroad company shares, bicycles, radio and telecommunications —which contributed to the 1929 financial crisis— , and so on. What all these have in common is that they were technological innovations in their time. They are also correlated to the appearance of a new financial technology. Bitcoin fits both of these criteria, with its high volatility an additional factor: its sudden drop in value in early 2018 therefore shares a number of features with well known bubbles.

How do you explain this sudden drop when bitcoin's value had been constantly increasing until then?

It is very difficult to define why a given asset, whether bitcoin or anything else, loses its value. There is currently no clear theory on this topic. Hacker attacks on several bitcoin exchange platforms have certainly played a part. There will most likely be more bubbles related to virtual currencies such as bitcoin, but it is impossible to predict them!

There are other virtual currencies: darkcoin, ethereum, litecoin… How similar are they to bitcoin? What is notable about them?

There is significant competition on the virtual currency market today. All these currencies are based on the same founding principle as bitcoin: they represent pure exchange value, and are not backed by a tangible product. They do not all behave like bitcoin, however, and they react differently to market fluctuations: this can benefit investors who are seeking to diversify their portfolios. Still, all virtual currencies are subject to the same risk of fraud: they are not supported by a central bank, exchange platforms may engage in fraud, etc. The virtual currency market is not subject to controls of any kind.

The issue of regulation is a central one when it comes to the future of current virtual currencies, including bitcoin…

That's right: regulation could harm bitcoin's attractiveness, which is based on lack of regulation and dependency on traditional financial markets —before it became a financial asset in its own right, bitcoin was used to make illegal purchases and launder money. Several central banks have already expressed interest in the blockchain technology, and may even launch their own virtual currency. Such a currency would be controlled and backed by an official institution, unlike other virtual currencies that are in use today.

So the blockchain technology is attracting financial players, but not only…

Where blockchain innovates is that it guarantees transactions: these cannot be modified by third parties. This is what makes the technology an attractive one. For instance, blockchain codes have been associated to artwork to prevent forgery. They might also be used in luxury goods, to fight counterfeiting. Unfortunately, blockchain is based on solving complex algorithms that require considerable processing power. The energy used in solving these problems has been pointed out as a problem (Ed.: data centres where the calculations involved in bitcoin are done consume as much energy as 159 countries according to "Le Soir"). This is the dark side of this new technology, and another hurdle to be overcome if it is to become successful.